Summary
- Hexagon Composites including stock listed Purus business keeps growing at impressive rates.
- However, margins came under pressure.
- This article updates my initial coverage and reiterates my tilt towards owning Hexagon.
This is the first follow-up article to my initial coverage of Hexagon Composites ASA ( OTCPK:HXGCF ), including its stock listed subsidiary Hexagon Purus ( OTCPK:HPURF ).
My overall assessment is unchanged in that I believe Hexagon Composites to be a very reasonable long-term investment for all that want to benefit from the urgently needed transformation of the energy system. This is despite the recent appreciation of the stock price – Hexagon Composites continues to steadily and yet significantly increase in revenue. However, it currently continues to struggle with the margin, especially in its largest business, Agility.
Introduction – Segments
In this article I will only briefly recall the offerings of Hexagon Composites Group and refer readers to the first article for more details.
In order to facilitate direct references to the key businesses, here is a quick introduction into the (IFRS reporting) segments of Hexagon Composites Group (or simply Hexagon or even just HC):
Hexagon Agility (2022 Revenue of NOK 3.5bn)
Offers type 4 cylinders for mobile pipelines operators of natural gas, where type 4 refers to the generation of cylinders used for gas transportation and storage. These cylinders are made of composite materials (e.g., by combining a carbon fiber reinforced plastic structure with an internal liner made of gas-tight, polyethylene plastic). Mobile pipeline cylinders are up to 40 feet long.
Agility also sells type 4 cylinders to truck makers that fit their vehicles with natural gas engines that require storage of gas as a fuel. Here, products of Agility’s customers range from HDV (heavy duty vehicles), including refuse trucks, over to transit buses.
Hexagon Ragasco (2022 Revenue of NOK 0.7bn)
Sells small cylinders used for both leisure activities (barbecue, camping) and basic needs (cooking in global regions with weak infrastructure) that rely on LPG (liquefied petroleum gas). Customers involve individuals as well as business customers in LPG distribution and forklift suppliers.
Ragasco is the only end consumer facing business of Hexagon.
Hexagon Digital Wave (2022 Revenue of NOK 0.1bn)
Digital Wave manufactures UE (Ultrasonic Examination) cylinder testing equipment and MAE (Modal Acoustic Emission) testing equipment. It also provides associated inspection services. Its customers include government entities, academic institutes, and private clients in the compressed gas and pressure vessel industries.
Digital Wave has the most significant share of service offering, and is referred to by management as an asset-light business.
Hexagon Purus (2022 Revenue of NOK 0.96bn)
Hexagon Purus (or simply Purus or even just HP) is a stock listed entity, of which Hexagon Composites Group currently holds 73.3%. This segment covers all activities covering hydrogen and batteries. Similar to Agility, it offers mobile pipeline cylinders as well as on board storage solutions – the range of vehicles is quite wide, covering trucks, cars, marine vessels and trains.
Purus itself does not report any segments, however Purus management regularly provides financial information about what they refer to as the “Wystrach business”, named after the 2021 acquired specialist provider of mobile pipeline and storage solutions for hydrogen.
Contribution to Group Financials
The four segments are of significantly different size, grow at significantly different rates and operate on significantly different profitability levels. For its basic capital market communication, HC uses revenue (and revenue growth) as well as unadjusted EBITDA margins. The following graphs show the contribution of each segment (and on a fully consolidated basis for Purus):
Ownership and Purus Situation
Hexagon Group has the following shares in the businesses discussed so far:
The group also holds 40% stakes in two entities developing solutions to store gases in liquid form, but neither of them are operational. I thus will not address these entities (Cryoshelter) any further.
HC management has stated may times that they will reduce the group’s share in Hexagon Purus to below 50% over time, but they did not give any roadmap.
Probably relevant in this context is the postponed 4q22 earnings call for Purus, the stock listed entity. Instead of following the usual pattern by which HP reports its financials a day or two in advance of HC, HP just issued a rather slim set of key metrics for 4q22. Here is the official reason for the postponing (per Purus’ trading update ):
This change is made to facilitate the preparations required for a potential transfer of the Company’s shares to the main list of the Oslo Stock Exchange. A final decision by the Board of Directors to apply for a transfer to the main list of the Oslo Stock Exchange will be subject to prevailing market conditions at that time.
I am not an expert for listing regimes, so I do not fully understand this statement. My naïve thinking would be that “prevailing market” conditions should only be relevant in case of stock issues, not for a mere move in listing. Since main listings may come with requirements for free float – in relative but also in absolute terms – this may simply mean that Hexagon Group is contemplating a capital increase for Purus. This would fit to the just mentioned goal of reducing the group’s stake – and as we will discuss below it also fits well with the ongoing cash needs for capacity expansion at Purus.
But to be clear, to my knowledge, no such statement was made by any Hexagon representative, and there wasn’t even a specific question publicly asked by any analyst at the HC’s 4q22 earnings call held two days after the scheduled date of the effectively postponed event for Purus.
Some terminology
In any case, Purus is different from the rest of Hexagon, especially with respect to the margins earned. As a result, HC management typically discusses Purus separate from the remaining business.
I will do so, too, in this article, and for ease of reference I will simply refer to Hexagon excluding Purus, or HCxP, for these businesses.
And finally, all quotes in this article, unless otherwise stated come from one of the following sources:
- Hexagon Group 3q22 Earnings Call (or: EC_3q)
- Hexagon Group 4q22 Earnings Call (or: EC_4q) – both available here
- Hexagon Purus 3q22 Earnings Call (or: EC_3qP) – available here
With that, we can now turn to the actual business development during the last four months:
Innovation
The overall environment for technologies that help reduce emission of GHG (greenhouse gases) benefits from strong tailwinds, now that governments, wide parts of society and even large corporates have begun to understand that fighting climate change is key. And most likely much cheaper than dealing with the accumulating effects of status-quo GHG emissions.
So, there is general interest in the products of Hexagon Group (and I refer readers to my previous article for some more details). This is a positive for any business, but no business and no technology can succeed in the long term without innovation.
For Hexagon investors it is thus comforting to see innovation to continue – and interesting to see how physical things get immediately when one looks at machine building companies.
Before we have a closer look at current and near-term developments by Hexagon Group, we start with a new product from a company that Hexagon has hardly any (direct) business with: US engine maker Cummins ( CMI ).
Third Party Innovation
So, what did CMI do? Well, they announced a 15 litre (15l) natural gas engine for heavy duty trucking will be fully launched in 2024.
And why is that so important to Hexagon, especially Agility? Because it essentially makes natural gas engines a fully equivalent alternative to Diesel engines on the entire North American truck market. This is due to the range offered ( up to 750 miles ), and – according to an HC management comment during the 3q22 HC EC – simple because it needs such a large engine to reasonably cross the Rocky Mountains with a heavy duty truck.
Once CMI’s engine starts to roll-out, in theory pretty much any new truck may be run on natural gas. And one can already see how large truck makers announce the adoption of the 15l engine for their key brands, take for example this press release from Paccar, Inc ( PCAR ) for their Kenworth and Peterbilt truck brands.
This is a golden opportunity for Agility and its gas cylinder peers, because any truck running on a natural gas engine needs on-board gas storage and accompanying systems. (So, the direct business relationship is between Agility and truck makers, not CMI, who kind of act like a catalyst.)
Here is a screenshot from the 4q22 presentation summarising the above:
Asked by analysts how optimistic Hexagon’s management is about this opportunity, they just said two words: “Very optimistic”. And if you want to watch truly optimistic people expressing their optimism non-verbally as well, you may just watch the EC recording here . (By the way: This should be music to the ears of CMI shareholders, too.)
But for completeness, management also said, that the upcoming launch may dim business in the second half of 2023 because of deferred orders until the 15l engine is finally available. (And it goes without saying that any delay with the engine is outside any control by Hexagon, but would most likely have an adverse effect on its business for the period of delay.)
Innovation – By Hexagon
So, that was great news from CMI and Hexagon too, but HC did not rest on their laurels and instead kept improving their products.
Agility comes first, again: It introduced a new generation of 40ft mobile pipeline systems based on its TITAN 450 module. You can see some obvious advantages directly in the below slide from the 4q22 EC – more volume with less weight with the exact same size system as before, obviously generating lower transportation cost for the mobile pipeline operating customer:
And there is one additional improvement that was only mentioned in the verbal notes to the slide: According to Hexagon management, this new system has the lowest gravity point in the entire market. And this is a key advantage as it comes with the lowest risk of roll-over of the trailer – an unpleasant way to be reminded of the physics of heavy-duty transportation.
But the innovation does not stop at Agility. Ragasco runs a somewhat lower profile innovation program “in the background”. The business will run a large-scale field test in 2023 for its “Smart Cylinder” innovation, see for example the 3q22 EC slides for HC.
Ragasco summarised the specifics of the new technology in a January 2021 press release :
Hexagon Ragasco has brought the LPG cylinder into the digital age, developing an “Internet of Things” ((IOT)) offer that enables the connection of Hexagon Ragasco’s LPG composite cylinders to consumers’ mobile phones - as well as to the IT systems of LPG distributors. The technology allows users to have full control of the remaining gas level of their cylinder and therefore prevents usage disruptions in their domestic (cooking and heating) or leisure (barbequing) activities. Furthermore, it enables LPG distributors to tailor their stocks and supply logistics based on real-time data.
Clearly a useful feature – for both Ragasco’s B2B and B2C customers. As we will see below, Ragasco currently delivers the richest margin among all HC segments, thus any sales boost here should do the entire business very well.
And finally, HC’s smallest unit Digital Wave also had great news in early 2023 (with emphasis added):
Hexagon Digital Wave will deliver a UE7 Ultrasonic Examination ((UE)) machine to CP Industries. UE machines have traditionally been used to perform periodic requalification of metallic pressure vessels (…).
CP Industries will utilize its UE7 to verify the integrity of their manufacturing process for Type 1 steel cylinders, commonly used in steel tube trailers. The UE7 is the largest machine in Hexagon Digital Wave’s UE portfolio, capable of testing cylinders up to 40 feet in length. This represents a new market segment for Hexagon Digital Wave’s UE technology.
This demonstrates the prospects of Digital Wave in two ways:
- It shows that its examination equipment may be used throughout the entire lifespan of cylinders, i.e. from manufacturing, through ongoing monitoring to requalification.
- And it shows that the equipment is not limited to type 4 cylinders, i.e. the core business of most of the rest of Hexagon Group but also with “plain” steel cylinders.
Overall, great prospects – and again, we will soon see how rich the margins are even for fast growing Digital Wave (due to some part to the asset-light requalification service business also part of this segment).
It’s The Capacity, Stupid!
The very promising outlook discussed so far comes with practical consequences:
According to management, the current hydrogen distribution capacity at Purus is already fully booked for 2023. So, yet another version of this article’s overall motive: Capacity is needed, and for a business like Hexagon this means hard assets for manufacturing and assembly.
So, for Purus alone, Hexagon started 2023 with five expansion projects:
- Doubling the existing Wystrach capacity in Germany – expected to be completed in 3q23
- Moving to a larger facility in the US – completed in January 2023
- Three additional projects in different locations all at different stages but all expected to go operational during the course of 2023:
- One site in Canada
- One additional site in Germany
- One site in China, which is the least developed project due to the many lockdowns in China until the fall of 2022
As a result of these projects in progress, currently Purus relies heavily on Agility supplies.
But according to HC management, once completed, the mentioned sites should provide more than enough capacity for Purus’ 2025 Revenue targets of NOK 4-5 bn. We will come back to this aspect when discussing valuation.
But before we move on, here is a quick summary of how management sees the different markets that Purus is active in (most statements taken from Purus’ 3q22 EC):
- H2 distribution is in “early serial stage and on a secular growth path”
- All other businesses will continue to be “a bit lumpy”, because they mostly deal with prototypes and test vehicles / fleets.
- In other words, these other segments “will be up and down until they reach the commercial stage” – H2 transit buses where mentioned specifically to be “in the early innings of commercial stage”
- This latter assessment in November 2022 has meanwhile been supported by a large order from Deutsche Bahn’s (Germany’s state owned railway company) transit bus subsidiary: The order is for mobile hydrogen refueling stations and stationary storage.
- Management also repeatedly emphasises the relevance the LTAs (long-term agreement) that Purus has entered into with OEMs. According to Purus and HC management, these LTAs do not only provide Hexagon management with visibility especially with regards to the ambitious growth goals for Purus. In the first place, they reflect the demand from OEMs, in the respective space.
- When asked by an analyst about Purus’ long-term business mix between battery and H2 solution, management said that this was hard to estimate. Right now, H2 distribution dominates and H2 will probably be dominating (even though each H2 vehicle has to have a battery, of course).
- I find this answer absolutely sensible when considering the ongoing discussions about energy transformation. It is obvious that this transition will involve molecules (i.e. a physical object, here we are again) to store energy mid-term and longer-term, and H2 will play a role here, even though the final call on the exact technologies cannot be made yet. For vehicles, the race between battery and molecule is way more open, despite the current obvious lead of battery electric cars.
In terms of overall demand visibility, the picture is not too different for Agility : The 2023 order book is almost filled for mobile pipeline, and management also expects resilient volumes for refuse trucks and transit buses. For heavy duty vehicles they reported a good order book for the first half of 2023, and reiterated some uncertainty regarding the second half, which may already be affected by customers anticipating the 15l Cummings engine.
Consequently, Agility started an expansion in early 2023 as well, and management expects the resulting additional capacity to be on-stream to meet the expected 2024 demand (of which we know that they expect it to be very promising). We will come to this deal and its financing in the next section.
For Ragasco, management expects “very healthy demand” that is expected “to fill the factory”. No expansion projects were mentioned here, or specifically for Digital Wave .
Let’s Talk About Cash
One can’t discuss capacity expansion, especially for a fast-growing group like Hexagon, without discussing the cash needs.
I generated the following table directly from a slide in each quarterly EC presentation of the entire group. Thus, all numbers come directly from management, I just added subtotals and did some moderate grouping as explained directly below. Here is the data:
Some comments on the table:
- Per column, I present the quarter-by-quarter data, as well as the aggregate values for the entire fiscal year in the last column to the right.
- The top cells cover the cash movements for HCxP, the lower cells cover Purus.
- Cells shaded in grey mark totals and subtotals.
- Cells shaded in light blue refer to the “Operating Activities” in the CF statement.
- Cells shaded in light red refer to “Investing Activities” – this covers capacity expansion, in particular.
- Cells shaded in dark green and white font show the subtotal of “Operating” and “Investing”
It is obvious from the above table that Purus used a lot of cash in 2022, not surprisingly, considering the pace at which the company is growing, not only in tangible assets like production sides, but also in terms of headcount etc. For Purus, the key information for cash are as follows:
- We do not have detailed information for 4q22, because of the postponed financial reporting date for this listed company. However, the HC 4q22 slide set provides for some information.
- First, as of December 31, 2022, Purus held cash of NOK 382 million. It had IBD (interest bearing debt) of as little as NOK 44 million.
- Per the above table, this compares to a 2022 cash burn of some NOK 670 million, i.e. some 177% of cash at hand at the end of the year.
- Unfortunately, we do not know which effect contributed to the positive operating cash flow in 4q22 – it could easily be due to a one-off, such as a large delivery (or payment for some past, present or future delivery).
- In either case, Purus management had made clear during Purus’ 3q22 earnings call that they expect to reach EBITDA breakeven in 2025, with cash breakeven slightly lagging, due to working capital needs.
- Thus, there will be further investments and thus cash needs, in particular for 2023 with four expansion projects still in progress, and the one in China just picking up steam.
The bottom-line is, Purus will soon need cash. There is bank lines, but investors should be – and most likely are – prepared for additional equity to be issued, too.
For HCxP, things are basically the other way around: There is a total IBD of NOK 1,673 million and cash of NOK 332 million in the Balance Sheet, making for NIBD (Net IBD) of NOK 1,341 million. Proforma HCxP NIBD / EBITDA is 3.9 at the current stressed EBITDA levels. Net interest expense is NOK 82 million.
This compares to a 2022 net inflow from Operating and Investing activities of NOK 133 million, per the first dark green line in the table above. So essentially, the business is cash supporting itself.
But the sign may change here temporarily, for two reasons: a) The current capacity expansion for Agility in the US and b) the anticipated interest for Agility in the HDV segment after the 15l engine launch. The latter may require additional working capital to finance the expected substantial growth.
For the former, management decided to enter a sale-and-leaseback-transaction for an existing US property. The new owner / landlord will in addition provide financing of the equipment of the expanded facility. So, any readers particularly interested in IFRS 16 Leases may find this standard at work here: Instead of incurring e.g. bank debt from borrowing funds and then spending it for e.g. equipment of the new facility, HCxP will report a lease asset (the right to use the equipment owned by someone else) and a lease liability (the obligation to pay that other party rent).
More practically, this transaction (highlighted in light yellow in the cash table) defers cash need into the future.
In a nutshell, nothing to really worry about at HCxP. Management also clarified, that “Hexagon Purus is ring-fenced from financial covenants in Hexagon loan agreements”. In other words, the cash needs of Purus and HCxP are widely independent of each other.
The Margins
With this, it is time to look at Hexagon’s margins.
Ragasco and Digital Wave
Let’s start with some positives: First, Hexagon Ragasco achieved EBITDA margins of 23% and 17% for in 4q22 and the FY22, respectively. This is the result of the ability to pass on higher input costs to customers (mostly starting in 2q22) – which may be easier in B2C business. In any case, the results show that HC management’s previously stated mid-term goal of achieving a 15% EBITDA margin appears reasonable – especially, once the business approaches full scale at the available capacity, as was the case for Ragasco in 4q22.
Also notable is the excellent EBTIDA-margin for the hyper-growth segment Digital Wave: It came in at 6% and 15% for 4q22 and FY22, respectively. This is impressive, given the fact that this business is currently entering new markets, which usually causes quite a drain on margins. But it certainly benefits from the “asset-light” model, that involves quite a bit of service provided to other companies. So, everything appears to be on the right track, here.
Agility
However, things are less rosy for the by far biggest segment, Agility. EBITDA margins came in at 5% and 6% for 4q22 and FY22.
This was the main disappointment in the year-end numbers. In previous calls, management had raised my hopes of margin improvements starting in 4q22 resulting from amended pricing.
Management discussed a couple of aspects during the 4q22 call:
- Due to the long-term nature of the contractual agreements, prices cannot be adjusted swiftly (which is a huge difference to Ragasco). And of course, especially when dealing with single large clients, you want to be careful to find agreements that all parties can live with. There was no discussion about the implications for Purus: Here, management also emphasizes the (relatively) high visibility of Revenue increases to come from LTAs (Long Term Agreements), but no questions were asked, and no comments were made, as to sales price inertness.
- The input prices for carbon fibre – obviously a key input to Agility’s products – kept climbing throughout all of 2022. Management said that they expect these fibre prices to plateau at the current levels. But the CFO also clarified the last mile of the price increases still needs to make its way into the margins. Which will happen once inventory of fibre bought at the peak prices becomes COGS (cost of goods sold).
It goes without saying that for an asset heavy business like Agility, a 5-6% EBITDA margin does not end up in a positive bottom-line, after allowing for the D’s, A’s and the I in EBITDA (and no significant T at these levels, of course).
Management reiterated the process of pricing adjustments, thus over time, investors should expect some improvements here.
Also, Agility, as well, is currently in the process of expanding its capacity for the expected 2024 and onwards demand increase, as discussed above. Once these expansion projects are completed, some margin pressure should ease. And once the capacity is actually used, scale effects should also do their favourable deed.
And then there is the overall global supply chain situation, which is outside of any individual management’s control. It is impossible to tell how the world will look 12 months from now, with respect to global conflicts, global diseases and other possible disrupting factors.
For Agility, management stated during the EC_4q that margins should be back to pre-COVID levels in early 2024. That would be a very welcome development, but despite the gradual effect from pricing adjustments it depends on a lot factors outside HC’s control, including actual scale (utilisation of expanded capacity), situation with the main customer for light duty vehicles (read: Volkswagen ( OTCPK:VWAGY )), and – as mentioned – the overall state of the world and its impact on supply chains (upstream and downstream from HC’s perspective).
Overall
Whatever the future brings, HC management does have some way to go in order to achieve the target EBITDA margin of 15% for HCxP.
For Purus, we saw a FY22 EBITDA margin of -42%. However, the Wystrach business, i.e. H2 mobile pipeline, achieved a (positive!) EBITDA margin of 7% for the first nine months of 2022. This is actually better than Agility, and it also shows that the non-Wystrach business currently bears the majority of the enormous investments made and the corresponding drag on margins.
Thoughts On Valuation
Over the last couple of years, HC changed quite a bit of its structure: It moved around the different businesses it is operating in between segments (although these appear to be stable for now) – this makes it challenging to track segment profitability over time. The most significant move was to go public with the hydrogen and battery business, i.e. Purus. It is an understandable move given the huge difference in stage-of-commercialisation for the technologies in this area. This is true despite the really promising pro-forma margins for Wystrach, i.e. the hydrogen distribution business.
Nonetheless, margin levels and cash needs are substantially different between Purus and the “residual” business (HCxP per my notation).
This is nothing new, as readers can see from the following quote from the 2019 Financial Report (bottom of page 9) – this was pre-Purus IPO:
14% Group EBITDA margin before Hydrogen investments
Still today HC management needs to communicate numbers for a blend of a very nicely growing, EBITDA positive, moderately cash-positive business and a hyper-growing cash burning business (that investors could buy on a stand-alone basis, if they’d wish to) that is large in the context of the overall group.
This creates a challenging task for any investor. For the remainder of this section, I will look at HC from these two “poles”: HCxP and Purus.
But let’s start with a basic overview of the current valuation. Please note that all prices are in NOK as of closing on Friday, February 24, 2023 at the Oslo stock exchange.
Market Valuation of Equity
Hexagon Composites closed at NOK 35.68 per share, yielding a market cap of NOK 7.2 bn. This is a nice performance from the October 15, 2022 closing price of NOK 22.26 / share that was the reference point for my first article (+60% performance). I guess it’s fair, though, to state that this is mostly explained by the overall market performance, especially in the high growth/high risk sector, during that period. There wasn’t really any game changing operational news, and overall margin development was more on the disappointing side of things for the time being.
Purus as well had a nice uptick since mid-October, all the way up to a current valuation of NOK 31.92 or a market cap of NOK 8.25bn – a 71% performance between the two articles (relative to the NOK/share market price at the time).
In October 2022, my conclusion had been that if HC was to meet its group 2025 revenue targets of NOK 6bn for HCxP and NOK 4-5 billion for Purus, investors should expect a 100+% upside potential over the roughly 3-year time horizon until the end of 2025.
So far, 60%-70% of that anticipated performance has been clocked in, so the question is: What is left to expect?
As discussed above:
- Margins need to catch up, especially for Agility
- Actual growth of Purus was even better than the ambitious guided levels – and both management and general public visibility for hydrogen projects and general relevance, respectively, have increased
- Growth at HCxP remains more than just solid – and Digital Wave seems to be on track to become a real gem within the group.
- As of this writing there have been no new large-scale distortions to global trade, even though my personal view is the macro picture has more downside than upside potential at this stage.
In any case, I will first look at HCxP valuation assuming one agrees to the market price of Purus to assess the price of the non-Purus business, and then look HCxP on its own to see the implied price for Purus. Investors may take any perspective in between.
Taking Purus Valuation as a Given
Here is the simple math to start with:
- HC – including a 73.3% stake in Purus – is measured at NOK 7.2bn
- 100% of Purus is measured at NOK 8.25 bn
- Accordingly, one could see HCxP as being measured at NOK 1.15 bn (=7.2 – 73.3%*8.25)
In other words, any investor believing that Purus is fairly valued at NOK 8.2 bn would get the total of Agility, Ragasco and Digital Wave for just North of NOK 1bn. As a reminder, this is a business growing at some 20% YoY, that generated NOK 4.3bn at an unadjusted EBITDA-margin of 7.8% (before consolidation effects that do not change the big picture at all) with absolutely reasonable leverage levels. This would be a bargain. Especially, if management were able to bring back HCxP EBITDA-margins to the 14% pre-COVID levels quoted above.
Starting off an HCxP Valuation
Management guided 2025 HCxP revenues of NOK 6 bn. Guidance for 2022 was very precise, so I would give management a lot of credit for turning their visibility into actual revenues per the guidance. Also, remembering that by 2025 the 15l engine should be around, an 11% CAGR (compound annual growth rate) does not sound off by any means, when considering the high weight of Agility.
We don’t know the path beyond 2025, we don’t even know the exact capacity HCxP will have by then to support further growth. And of course, we don’t know the margin levels by then (by segment and for HCxP as a whole). So, there is considerable uncertainty as to what price the market will place on HCxP if it were to meet the growth path exactly.
I stick to my previous approach of assuming a trailing price-sales-ratio of 1.0 – for perspective, CMI currently trades at a trailing P/S ratio of about 1.3 for a business with 13% EBITDA-margin. This approach would yield a NOK 6 bn valuation for HCxP by end of 2025, or of some NOK 4.1 bn as of today assuming a 13% discount (my minimum requirement assuming a rather prudent estimate based on trailing P/S etc.)
With this, we can do the inverse calculation:
- HCxP value of NOK 4.1bn…
- … yields a NOK 3.1 bn valuation for 73.3% of Purus…
- … yields a NOK 4.2 bn valuation of Purus
Now What About Purus?
What do all these rather simplified valuation exercises tell us?
In the end, as an HC investor one cannot avoid expressing an explicit view on Purus. It is the hardest part of all, because so much of the value generation of this business is “future only”. And, of course, because there is uncertainty about the details regarding the growth funding.
The two most promising data points are the impressive growth that management expects to continue. And the favourable EBITDA-margins levels indicated for Wystrach for the first nine months of 2022, see page 16 of Purus’ 3q22 presentation: Here, Wystrach accounted for two thirds of Purus’ revenue at a 7% EBITDA-margin, and as stated above already, I do believe that hydrogen will play a central role in the developing Power-to-Molecule solutions. This should give Wystrach, and thus Purus, excellent prospects.
But we don’t really know the prospects of the other businesses, especially in terms of relevance of H2 in any segment of transportation and the market position Purus could hold in battery business. A lot of cash is going into those activities, and I am still in a show-me state.
Right now, the market is valuing Purus at 8.6* trailing revenue (based on NOK 0.96 bn revenue (unaudited) for 2022), or at some 5.7 * forward revenue (based on a 50% revenue growth that management is expecting to achieve at a minimum, all per the aforementioned February 6, 2023 press release ). This is all pre diluting capital increases, if any, but I remind readers that HC management indicated they would reduce their stake to below 50%. Assuming that this will not result in HC actively selling Purus shares, this would imply some 33% Purus dilution mid-term.
To cut a long-story short: The mid-point of Purus revenue guidance for 2025 is NOK 4.5bn. I am convinced that there will be substantial growth beyond this year, but considering all the uncertainty, I am unwilling to give more than a 2025 trailing P/S of 2, i.e. a year end valuation for Purus of NOK 9 bn. Discounted at 13% again (because I put some prudence into the multiple) this yields a current valuation of NOK 6.2 bn.
My Conclusion
While I see the potential for Purus, I do not understand the risks of this business well enough to feel comfortable with a direct investment that is not insignificant.
At my NOK 6.2 bn Purus measurement, I end up with a price tag for HCxP of NOK 2.66 bn, well below my cautious valuation of NOK 4.1bn.
As a result, I keep favouring HC over Purus. Since I believe the entire business to have very good prospects, I now hold a “full” position in HC and a “pro memoria” position in Purus (more specifically, my total exposure to the entire Hexagon Composite group is 95% HC and 5% Purus, all long and direct equity holdings).
I am more than happy of course for readers to share their view in the comments.
For further details see:
Hexagon Composites ASA: Let's Get Physical